Saving Puerto Rico Requires Labor Market Reforms

Puerto Rico’s financial woes have been all over the news lately. Its debt has reached $73 billion dollars in a country with a Gross Domestic Product (GDP) of only $103 billion, and debt service currently consumes one-third of the country’s annual tax revenue. The Obama administration has proposed allowing Puerto Rico to declare bankruptcy, an option that is currently only available to municipalities in the 50 U.S. states but not states or territories themselves. Several economists and former Obama administration officials have come out in favor of the White House’s plan, including Larry Summers, who was the Director of the National Economic Council under Obama.  While Puerto Rico’s broader economic struggles have been discussed, the White House plan largely ignores them in its solution, instead proposing Band-Aids like an expanded Earned Income Tax Credit (EITC) and Medicaid reform. These reforms may provide a small amount of relief in the short run, but more structural reforms need to take place before Puerto Rico can prosper on its own.

Many people don’t realize just how bad Puerto Rico’s economy – especially its labor market – really is right now. In 2014 Puerto Rico’s poverty rate was just over 45 percent. Mississippi, one of the least wealthy states in the US, had a poverty rate of only 22 percent. A moderate expansion of the EITC is not going to eliminate that gap. Moreover, only people who work are eligible for the EITC and in Puerto Rico only about half the island’s residents are employed. The labor force participation rate for people 16 and over was only 45 percent in Puerto Rico in 2014 compared to 58 percent in Mississippi and 63 percent for the U.S. as a whole. Even worse, only 35 percent of Puerto Ricans 16 and over were employed in 2014 – a shockingly low rate. In Mississippi 52 percent of eligible workers were employed. With so few people employed it is not surprising that Puerto Rico has trouble paying its debts. Public debt service requires public revenue, which is primarily raised via income taxes. When hardly anyone is working, there is hardly anyone to tax.

One U.S. policy that contributes to Puerto Rico’s weak labor market is the federal minimum wage. In 1983 Puerto Rico was required to start enforcing U.S. minimum wage policies. Up to that point the commonwealth was allowed to have a minimum wage lower than that of the mainland. This makes sense since workers in Puerto Rico are less productive than those on the mainland. For example, the median individual yearly income in Puerto Rico was $18,928 in 2014, compared to $39,680 in Mississippi and $61,933 in the high-wage state of California. Making each of these areas abide by the same minimum wage law negatively impacts their labor markets by different amounts. A worker earning the minimum wage in Puerto Rico makes almost 80 percent of the salary a worker earning the median wage does, compared to only 24 percent in California. If minimum wage workers in California earned 80 percent of the state’s median worker they would make $23.82 per hour, or almost $50,000 per year! Does anyone really believe that a minimum salary of $50,000 per year wouldn’t make it difficult for people to find jobs in California? With policies like this we shouldn’t be surprised that Puerto Rico’s labor market is so terrible.

Any plan for assisting Puerto Rico that doesn’t address the fundamental labor market issues will fail in the long run. Over 200,000 people have left Puerto Rico since 2010, and many of them had college degrees and were in their prime earning years. The Puerto Rican government needs to be encouraged and empowered to implement crucial labor market reforms that expand economic opportunity in the commonwealth. Otherwise talented, ambitious workers will continue to flee the country in droves, further eroding Puerto Rico’s tax base and making it difficult for the government to stay out of debt long term.